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Analysis: What would be the economic cost of a full-blown Taiwan crisis?

  • August 16, 2022
  • , The Japan Times
  • English Press
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As larger and more intense Chinese military exercises around Taiwan become the new norm, there are growing concerns that a miscalculation could result in a full-blown cross-strait crisis with not only potential military consequences but also far-reaching economic ones.


The increased risks were once again brought to the fore when China staged fresh military drills around the self-ruled island Monday, slamming a new unannounced two-day visit by U.S. lawmakers to Taipei following a similar trip by U.S. House Speaker Nancy Pelosi earlier this month that triggered a furious response from Beijing.


The five-member congressional delegation — led by Sen. Ed Markey of Massachusetts — met with President Tsai Ing-wen, sparking strong condemnation from Beijing, which claims Taiwan as part of its inherent territory and views such visits as violations of its “One China” principle.


To try and manage the rising tensions over Taiwan and ensure that Sino-U.S. competition doesn’t lead to conflict, Chinese President Xi Jinping reportedly aims to hold his first in-person meeting with Biden in November, the first since the American leader’s inauguration.


Besides the military implications, an escalation of the situation is also bound to have economic repercussions, with Beijing showing earlier this month that it is willing to use economic tools to up the pressure on Taipei, which has remained defiant throughout the standoff with China.


For instance, following Pelosi’s visit, China suspended exports of natural sand to the island, which are key for construction work, and halted imports from Taiwan of certain types of fruit and fish. That said, analysts say these measures are likely to have only a minor effect on Taiwan’s economy.


Closely integrated economies


China is not only Taiwan’s largest export market but also its largest source of imports, accounting for about 33% of the island’s total foreign trade, meaning that stricter economic measures could have a significant impact on Taiwan’s economy.


However, the two economies are also closely intertwined, particularly their respective electronics industries, with Taiwan being China’s top source of imported integrated circuits.


In 2021, 42% of Taiwan’s total exports went to China, including Hong Kong.


According to Rajiv Biswas, Asia-Pacific chief economist at S&P Global Market Intelligence, semiconductors accounted for an estimated 35% of the island’s overall exports last year, highlighting the importance of Taiwan’s electronics industry not only for China but also for global manufacturing supply chains.


The strong integration between the Chinese and Taiwanese economies has led some analysts to say there is very little chance of China imposing stricter economic sanctions on Taiwanese businesses, as this would end up hurting crucial sectors of the Chinese economy.


“If Beijing imposed restrictions on manufactured products from Taiwan, this would be very disruptive to China’s supply chains and exports. So, it is unlikely that Beijing would choose this route,” said David Dollar, an expert on China’s economy at the Brookings Institution. “Any major trade sanctions aimed at Taiwan would hurt the whole East Asian economy.”


Moreover, if a conflict were to erupt, China, which heavily depends on exports to maintain economic growth, would likely face an array of international sanctions and boycotts of Chinese-made goods and services — just as Russia faces now over its war against Ukraine.


However, as shown by Moscow’s invasion, the risk of economic hardship is not always enough to deter an aggressor from achieving a certain goal. If reunifying Taiwan with the mainland means enough to China to up the ante, then it will be very challenging to deter Beijing, regardless of the economic consequences.


The cost of a full-blown crisis


The impact of a full-blown cross-strait crisis that would cut off Taiwan’s exports from the rest of the world would be felt far beyond the immediate neighborhood.


The reason for this is that Taiwan matters far more to the world economy than its 1% share of global gross domestic product would indicate, as Gareth Leather, a senior Asia economist at Capital Economics, pointed out in a recent report.


Taiwan, which is also very closely integrated with the economies of Japan, South Korea and the United States, is by far the world’s biggest producer of the processor chips that are increasingly ubiquitous in new products. It has twice the market share of the next biggest producer, and its dominance at the high end is even greater, with 92% of the most advanced semiconductors made by the Taiwan Semiconductor Manufacturing Company (TSMC).


This, Leather wrote, represents a risk for the global economy. Even if a full-blown conflict were avoided, a military blockade of the island would still cause “a major economic shock to the global economy as it would lead to renewed shortages in the automotive and electronics sectors and put further upward pressure on inflation.”


Mark Williams, chief Asia economist at Capital Economics, has a similar view. He argues that Taiwan’s key vulnerability is its dependence on imported fuel, noting that a fuel blockade could soon cripple the island’s industries, as it would result in large disruptions to the energy supply and potentially halt manufacturing.


Only 12% of Taiwan’s energy comes from domestically produced fuels, renewable sources or nuclear power. As Williams noted in a report, the island’s key vulnerability in this regard is its electricity supply, with power generation heavily and increasingly dependent on imported liquefied natural gas (LNG).


“37% of electricity was gas-generated last year. The last operating nuclear plant in Taiwan is due to shut down in 2025 and the government has a longstanding goal of closing the gap with more gas power. Its target is to raise the share of electricity generated using natural gas to 50% by then,” Williams wrote, pointing out that an interruption of LNG imports would therefore result in “a substantial drop in power generating capacity within days.”


Even a porous blockade that allowed fuel through would cause huge global economic disruption.


“The prospect of high-end chip supply being cut off soon would lead to stockpiling. In turn, Western governments would come under pressure to help break the blockade,” Williams wrote.


Leather explained that if Taiwan’s semiconductor supplies were disrupted for a prolonged period, electronics and automotive manufacturers would struggle to find alternative suppliers, forcing many firms to halt production.


And in a case where production facilities were badly damaged, the disruption would last until replacement manufacturing capacity was added in Asia or elsewhere.


“It takes two-to-three years to build a semiconductor plant from scratch. Replacing lost manufacturing capacity would be extremely expensive — a new semiconductor factory costs tens of billions of dollars and it is extremely knowledge intensive; indeed, TSMC dominates at the cutting edge because of its technological lead,” Leather wrote in a separate note.


He also stated that it would be impossible to re-establish TSMC’s most advanced facilities without its personnel and intellectual property, meaning that the longer the disruption continued, the more the indirect costs to the global economy would mount.


“Expansion and the launch of new services and firms would be harder. And without ready access to the fastest chips, innovation in areas such as artificial intelligence would slow,” he wrote.


Amid the growing risks, countries reliant on Taiwanese semiconductors have begun taking action. For instance, Biden recently signed into law a spending package under the CHIPS and Science Act that allocates $52 billion to strengthen American chip manufacturing, a move that S&P Global Market Intelligence’s Biswas says is intended to reduce vulnerability to supply chain disruptions or delays for semiconductor imports.


Moreover, TSMC is aiming to build a chip factory in the U.S., and Washington is planning to work more closely together with Japan and South Korea in the semiconductor industry.


Decoupling risk


But what would this mean for China? While Beijing has options other than a full-scale invasion to coerce Taiwan into submitting to its political control, any scenario upsetting the existing cross-strait balance would risk further escalation that could lead to a hard decoupling of China from the West, according to Williams.


For instance, the analyst pointed out that China could put pressure on Taipei by seizing one or more of the uninhabited islands Taiwan controls in the South China Sea.


“Beijing may calculate that their seizure would send a message of resolve without risking major diplomatic, economic or financial blowback. But if Taiwan’s military put up a … fight, this could still catalyze a response by Taiwan’s allies, including tighter sanctions on trade.”


He argued that seizing an island in the Taiwan Strait would be seen by many as a precursor to an invasion, which would then lead to redoubled efforts to develop high-end semiconductor supply chains outside Taiwan.


“Firms in all sectors would take steps to decouple their China-facing operations from those serving markets elsewhere. Restrictions on exports of technology to China would be tightened and Western countries may respond to China upsetting the status quo in the Strait by making more explicit their support for Taiwan,” he wrote.


Considering this, Williams noted that crisis scenarios short of full invasion all come with a high risk of escalation.


“It may not be possible to restore stability after a major breach in the status quo. Even if not the initial intention, these scenarios could easily spiral towards a cross-Strait war and to a hard decoupling of China from the West,” he wrote.


Williams also pointed out that if China tried to invade Taiwan, regardless of whether it succeeded or not, this would likely result in asset freezes and the severance of most economic and financial ties, although such economic retaliation may be harder to stomach for many Western nations, which are much more dependent on trade with Beijing than they have ever been with Moscow.


That said, the biggest deterrence factor for Beijing would probably not be the Taiwanese military or the economic sanctions, but rather the expectation that the United States — and possibly some of its closest allies — would get involved in the defense of Taiwan. The form this involvement would take is unclear, since a direct military intervention would risk igniting a wider regional conflict.


At the same time, China itself could become the subject of a possible blockade of oil tankers and cargo vessels at the Malacca Strait — the world’s second-largest oil trade chokepoint after the Strait of Hormuz. Such a naval blockade could be used by an adversary force to deprive China of vital energy resources and potentially impact political stability in the country.


And even the ideal scenario, from Beijing’s perspective, of Taiwan capitulating under pressure early in a crisis, would trigger a wholesale reconfiguration of relations with the West.


“China would be the undisputed dominant power in Asia, but if the U.S. were unwilling to accept its own reduced position, it would attempt to shore up a global anti-China alliance and impose hard barriers on trade and financial flows,” wrote Williams.


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